Markets

I dont like my head being fcuked around with regarding Int. rates. I have thought for a while that the FED is going too far. Housing Market on the coasts is the scariest part. But, there is no pain. Either the mkts (stock and spread products which incl. Corp bonds, Home Eq, Cmbs, emerging mkts etc.) are horribly wrong or we r going thru a painless adjustment. which makes no sense. which leads to the conclusion that there is 2 much money and int. rates need to go up more :icon_eek: :no: . 2 of my favorite economists (Stephen Roach and Andy Xie - both from MS) have completely fcuked my head up. I think they are wrong. In my opinion, the US doesnt need to raise rates but China needs to slow down and Japan and Europe need to raise rates. China is going to implode. what the fcuk are they building so much capacity for? all of this capacity directed towards exports, fcuk. They are the ones pushing up the commodities.

Around the world, global policy makers are scrambling for traction. The world economy is in the midst of the strongest four-year boom since the early 1970s, yet both monetary and fiscal authorities in the major economies remain in stimulative positions. What are the implications of this stunning policy mismatch?

Global policy stimulus in 2006 is largely an outgrowth of the lingering impacts of the great deflation scare of 2003 -- which, itself, was a by-product of the bursting of the global equity bubble in 2000. This chain of events prompted central banks to declare “policy emergencies” in many cases -- especially in the United States. Meanwhile, the ECB followed a similar pattern as powerful structural headwinds brought Euro-zone activity to a near standstill, and the Bank of Japan redoubled its commitment to zero interest rates in order to break the back of a corrosive deflation. At the same time, fiscal authorities in the major advanced economies of the world were effectively co-opted by the politicians -- leaving budgetary policies equally stimulative.

Based on data aggregated by the IMF on the fiscal and monetary policies in the major advanced economies of the world, financial stimulus remains truly extraordinary. Short-term interest rates in the advanced economies aggregate stood at only around 3% in nominal terms in early 2006 -- up from their 1.4% lows of 2003 but still well below the nearly 5% highs of late 2000. With headline inflation having moved higher on the back of rising energy prices in recent years and core inflation inching up over the same period, today’s policy rates are even more stimulative in real, or inflation-adjusted terms, than they were in the 2000-03 period. Private credit growth was still surging at a 10.7% y-o-y rate in early 2006 -- a dramatic acceleration from the 2.6% low of early 2002 and even stronger than prior peak rates of credit expansion of 9.8% hit in the spring of 2000.

Fiscal policies in the advanced economies are equally out of kilter. IMF aggregations put general government budgetary balances -- federal plus state and local jurisdictions -- in combined deficit positions to the tune of 3.1% of advanced world GDP in 2005. While that’s down from the 4.1% peak fiscal gap in 2003, the narrowing is largely a by-product of the cyclical revenue windfall associated with the current global growth boom. Absent that transitory factor, there has been little evidence of any improvement in underlying fiscal positions in the advanced economies. According to IMF estimates, so-called structural budget deficits of general governments in the advanced economies stood at 3.0% of potential GDP in 2005; that’s down only slightly from peak structural deficits of 3.6% in 2003 and essentially double the 1.5% average shortfalls of 1998-99.

Of all the major economies in the world, I worry about policy stances in the US and China the most. Over the past five years, these two economies have been the major engines of the global economy -- with the US consumer driving the demand side and the Chinese producer driving the supply side. Both engines are clearly overheated -- US consumption has been hovering at a record 71% of GDP since early 2001 and Chinese industrial output growth surged to a record 19.5% y-o-y comparison in June 2006. Policy restraint is in order in both cases and yet the authorities have made only token gestures in that direction.

In the case of the United States, Federal Reserve Chairman Ben Bernanke’s latest message is certainly on the dovish side of the policy debate. At least that’s the interpretation I take from his willingness to send a message of the coming moderation of inflation literally a few hours after the release of a fourth consecutive monthly deterioration in the core CPI. While it’s always possible that Bernanke will reverse his opinion in the not-so-distant future -- continuing his penchant for flip-flopping that has been painfully evident since late April -- his latest statement of record is hardly suggestive of a Fed that wants to push monetary policy into the restrictive zone. That could well be a serious mistake, in my view. I have argued for some time that monetary policy needs to be biased toward the tighter side of the policy equation when underlying inflation rates are near price stability (see my 22 May 2006 dispatch, “Wake-Up Call for Central Banking”). To do otherwise runs the risk of multiple asset bubbles, wealth-dependent reductions in personal saving, and massive current account deficits -- the sustenance of ever-widening global imbalances. Bernanke’s latest policy statement all but ignores these risks, while at the same time paying little heed to incipient inflationary risks. In my view, that’s a serious blow to Fed credibility -- a worrisome development on the global policy scene.

China is in a similar position. Its economy is seriously overheated yet the Chinese leadership continues to respond to pressures arising from such unsustainably rapid growth by relying on a highly incremental approach to policy restraint (see my 21 July 2006 dispatch, “China’s Control Problem”). In large part, this is an outgrowth of the limited progress that China has made on the road to reform -- underscored by a highly fragmented banking sector. Chinese monetary policy can hardly be expected to achieve meaningful traction when it is aimed at restricting credit growth in China’s four largest banks, which collectively contain over 75,000 highly autonomous local branches. Nor should the recent increase in Chinese bank reserve ratios carry much clout, as China’s banking system has been in a chronic excess reserve position since the late 1990s. And, of course, China’s “quasi currency peg” severely constrains the autonomy of Chinese monetary policy and fosters a bias toward massive foreign exchange reserve accumulation, whose macro impacts spill over into China’s domestic liquidity and credit cycles. These excesses in the financial side of the Chinese macro equation beget more excesses in the real economy -- only exacerbating the pressures on an already overheated economy. In this context, limited moves toward policy restraint by Chinese authorities qualify as yet another worrisome development on the global policy front.

Macro policies have played important roles at key junctures in modern economic history. Modern-day stabilization policy was born out of the abyss of the Great Depression of the 1930s. Policy blunders beginning in the late 1960s and continuing through the 1970s gave rise to the Great Inflation. And a quarter century of stunning disinflation beginning in 1980s can be traceable to the triumph of central banking. The global economy could well be at an equally important juncture today -- facing the challenges of the post-disinflation era. Unfortunately, it is an era that is still awash with excess liquidity, biased toward multiple asset bubbles, and plagued with ever-mounting global imbalances. It is an era that needs a disciplined and focused bias toward policy restraint. Yet, today, it is not getting anything of the kind.

Three months ago -- April 22, to be precise -- the stewards of globalization woke up to the perils of ever-mounting global imbalances. In joint communiqués, both the G-7 and the IMF laid out the broad parameters of a reshaping of the global policy architecture that I still believe has great potential to foster a relatively benign global rebalancing (see my 1 May 2006 dispatch, “World on the Mend”). All along, the big risk in this approach has been that individual countries do not cooperate with the collective, or multi-lateral, solutions that a successful global rebalancing requires. Incremental shifts to global policy restraint are worrisome in that regard -- especially if they are concentrated in the US and China, the two most important players in any rebalancing. A still unbalanced world economy cannot afford to have its two most important economies fall behind the global policy curve.

Global inflation accelerates: Global inflation is at a 10-year high. The sources of inflation are broad-based, including overheating in emerging economies, rising commodity prices and tight labor markets in developed economies. By virtue of its global nature, inflation is likely to be strengthened by all these factors and keep climbing.

Global monetary conditions remain loose: Although the global real policy rate has climbed above zero in the past two years, it is still close to zero versus more than 2% five years ago. Monetary conditions are not restrictive, and global inflation is likely to climb further in the absence of additional tightening.

Global policy rate needs to rise by 2% or more: The rise in the global policy rate has to be 2% or more to return to neutral. To combat inflation, the rise needs to be considerably more. Rate hikes around the world will likely surprise on the upside.

Central banks have to respond to the facts: Major central banks have been dovish in their recent statements (e.g., the Fed, the BoJ and the PBoC). However, regardless of the wishes of the central bankers, the facts will eventually catch up with them. The more dovish they are now, the higher the level at which inflation will peak and the greater the rate hikes that they will have to make.

Major central banks have surprised the market with their dovish statements (e.g., the Fed, the BoJ and the PBoC), despite data that show rising inflation and overheating. The dependence of the global economy on financial markets may have caused the dovish tendency, as central banks are concerned about any damage to economies from financial market adjustments to a hawkish stance.

However, dovish positions cannot change the fact that global inflation is at a 10-year high and rising. Although the global real policy rate is no longer negative, it is still close to zero. The economies of China and India and commodity markets are overheating, and if the global policy rate remains at such low levels, further overheating can be expected.

The dovish stance of the major central banks increases the risk of a global hard landing as it encourages overheating in the economies of developing countries and commodity speculation. This is likely to cause global inflation to peak out at higher levels than would otherwise be the case. There is also a risk that central bankers will suddenly panic when they realize that their low interest rate policies are completely out of sync with the facts; they may then overcompensate by raising rates sharply and trigger a crash.

Easy monetary conditions fuel inflation

Global inflation is at a 10-year high and probably reached an average of 2.9% for China, the Euro-zone, Japan, the UK and the US combined in June 2006, from an average of 1.2% in 2002. Recent data from all over the world suggest that the rising inflation trend is still intact.

The global inflation debate focuses on the source of inflation. The rise in oil prices is considered the main culprit. Rising rents are another. However, this sort of thinking misses the big picture. Inflation is picking up because of an easy monetary environment. The money stock in the world is too high for price stability.

Central banks have been able to keep monetary policy loose without worrying about inflation for a decade. Deflationary shocks (e.g., emerging market crisis, 9-11, China’s SoE reform and Japan’s banking reform) have kept inflation down despite the easy monetary environment. As the effects of these deflation shocks end, the current money stock becomes inflationary. The rise in oil prices, for example, just reflects excess money supply turning into inflation through strong demand or speculation.

Central banks around the world have been raising interest rates for two years. Gradualism in monetary normalization has made the tightening less effective. While the policy rate is rising, inflation is too. I estimate that the real policy rate is still about half a percentage point from the rate that would be sufficient to contain inflation and speculation.

Central banks are creating problems for themselves

Despite mounting evidence of high and accelerating inflation, major central banks have made dovish statements, which have confused financial markets. The BoJ talked down the prospect of further rate hikes after it first raised rates. The Fed keeps telling the market that inflation will come down even though this contradicts the facts. The PBoC increased the deposit reserve ratio by a mere 0.5% after a barrage of data showing an overheating economy.

Do central banks know something that the markets do not? I don’t think so. Central banks are sounding dovish because they are concerned about the knock-on effect on the economy of the response by financial markets to higher interest rates. Financial markets have become so large relative to the economy that their behavior determines economic strength. In particular, the property market has become another financial market as a result of financial innovations. Central banks are trying to manipulate financial markets to achieve a soft landing.

However, what central banks are doing may backfire. Their dovish stance fuels commodity speculation, which is a major source of inflation. As the real policy rate is close to zero, already rampant speculation will only get worse. The stance that central banks are adopting is just encouraging speculators to double their bets. While central banks try to manipulate financial markets to their advantage, the result could be much more inflation, which would force aggressive rate hikes and the possibility of a crash.

Inflation is likely to keep rising

Inflation is a monetary phenomenon. Deflationary shocks held back its effect on CPI inflation. However, products and services with supply constraints have incurred rapid inflation for years. From trophy properties, Ivy League education, fine Bordeaux wine to antiques, prices have inflated along with money supply. It just takes time for the inflation to spill into the broad economy.

The economies that previously caused deflation are now all experiencing rising inflation. The commodity boom has recapitalized the emerging economies that suffered crises five years ago. After using export income to repair their balance sheets, they are now spending money rapidly.

China’s export prices have been rising for two years, according to Hong Kong’s data on Chinese imports. Rising prices of raw materials and increasing wages are contributing to this trend. China was a major force in limiting the inflation in tradable prices, which kept inflation low in OECD economies despite high services inflation. The changing trend in China’s export prices has a profound impact on the global inflation trend.

Japan’s consumption recovery should also add to global inflationary pressure. Japanese companies are converting temporary workers into permanent workers and are offering permanent jobs to first-time job seekers. This increases labor costs and boosts consumption. The Japanese economy is certainly not deflationary for the global economy.

The counterargument on all the above factors is that productivity is still high. When the money stock is too high (i.e., the money supply to GDP ratio is well above the historical average), accelerating productivity acts like a deflation shock, temporarily holding back the inflationary effect. However, ceteris paribus, the productivity growth rate is lower when an economic cycle has matured, as it has now. The effect is similar to the removal of a deflationary shock.

I expect a massive sell-off in bonds

Central banks, and particularly the Fed, seem to have become puppet masters for financial markets. Low inflation has made asset prices more dependent on liquidity than fundamentals. Therefore, a big chunk of global demand depends on inflated asset prices. This game works as long as inflation is not a problem. When inflation appears as it is now, central banks can no longer deal with the demand problem by simply pumping in liquidity.

Most central banks still do not believe that inflation is a serious problem, even though they pay lip service to it. They are waiting for the base effect from rising oil prices to taper off and believe that inflation will just disappear with time. I think this view is naive. Oil price inflation reflects excessive liquidity, which has pumped up demand and speculation. The latter will keep pushing up prices as long as the real interest rate is near zero and liquidity is plentiful.

Bond markets still believe that inflation is not a serious problem, a demand slowdown due to a cooling housing market and high oil prices will lower inflation, and central banks will cut interest rates in 2007. I believe that economic weakness would be insufficient to bring down inflation as long as the global real interest rate remains at such low levels. The world needs above-average real interest rates to keep the growth rate below trend for a prolonged period and reduce inflation.

The global macro economy is undergoing a transition from below-trend inflation and above-trend growth to above-trend inflation and below-trend growth. When the bond market accepts this, the bond yield could rise by 100bp or more, in my view.

If the Bond Markets sell off, housing is fcuked and there will be no safe haven but BUD, Coke, (all companies with tremendous pricing power) Gold etc. But, the rest of the asset mkts will just collapse.
I believe Roach and Xie are wrong but fcuk - never say never.

New home sales fell more than expected in June – down 3% m/m to 1.131
million units (annualized) but because of a huge downward revision to May (to
1.166mn from 1.23mn units) the decline did not look as bad as it could have.
In other words, off the unrevised May number, the June decline would have
exceeded 8%. On a year-over-year basis, sales are now down 11%.
Keep in mind too that the data do not take cancellations into account, and
when you see that sales of completed product down 9% in June and sales of
units under construction sagged 11%, the sales results are actually much
worse than the headline suggests. Sales of new homes not yet started (on
'plan') actually rose 2.6% last month, which inflated the headline – but the
movement of actual physical product is heading in the wrong direction.
Not only that, but as the sales decline, inventories continue to accumulate,
having risen 0.7% sequentially in June – taking the backlog to 6.1 months'
supply from 5.9 months in May. Together with total existing (single-family and
condo units) and newly-built backlog, this brings the total number of
residential units that have the For Sale in front of them but aren't selling to a
record-high of 4.3 million units, which is a mind-numbing 37% higher than the
level this time last year. As a result, the builders continue to discount –
median new home prices were cut 1.6% in June to $231,300 and this followed
a 7.4% slice in May (this does not include the stepped-up inducements and
freebies we're seeing right now).
In fact, median new home prices have plunged at a 21.6% annual rate
between February and June in what is the steepest slide since September
1990 when the economy was in a full-fledged downturn and the Fed was busy
scrambling to cut rates. The broad economy is obviously not in recession
(yet, that is) but the housing market is certainly behaving that way. And what
we saw on Tuesday was that the turndown in the new housing market in
terms of pricing is beginning to seep into the resale market and that is where
the rubber meets the road in terms of the wealth effect, savings rate and
personal consumption growth. It's called the New Deflation.
While we do not have new home prices by region, we do have the sales data
and the weakness is certainly broadly based: over the past year, new home
sales are down 34% in the Northeast, 24% in the Midwest, 7% in the West
and 5% in the South. So much for "it's only a problem on the coasts".

OK guys help me figure this one out....I have been following and owning Closed End Junk Bond funds for YEARS......with all this gloom and doom talk why are they going UP every day (which I love by the way since I own them) IGD, and EAD have gone nuts the last week and PHK is trading at a 5% premium.......Junk Bonds ALWAY tell what will happen in the future (3-6 months out especially). It is the best indicator that I know of :icon_mrgreen:

I am sure the PPT guys own a boat load of JUNK!

Click to expand...

when rates decline (tsy) they move more bec. they have a higher duration. So ceteris paribus, higher duration bonds will do better than lower duration bonds when rates decline and vice versa. but usually the spread (extra cushion) required moves out when the economy about to slow down.

and there in lies my problem. junk doesnt take a hit? what kind of a slowing down is this. u should see where junk is getting bid these days. Something is off. I can understand CMBS (historically low level of delinquencies and cant see anything wrong for another 6 to 12 mths) but the rest just doesnt make sense.

just got back from 11964 and 11937 - zip codes. Everytime I go there ( 2 of my friends own houses there) and come back I am just in awe. I live in NYC and thats probably the most imp. and powerful city on the planet. But, Greenwich,CT and the 2 places on top just blow my mind. This country has got so much money. Its just sick. Its also kind of depressing bec. I want to get to the position to own it myself and I dont want to be 60 to get there. The yatchs, boats, cars (I am sure u guys are used to that in CA) but its just mind boggling. My friend's place costs around 50m if not more in 11937 and the other one's about 5.5m. and the other property is around so that he can get away from the crowds in 11937. Its just sick.